FDIC Chair Cites Progress in Development of Orderly Liquidation Framework
Commentary by Steven Lofchie
FDIC Chair Mark J. Gruenberg boasted of the FDIC's "impressive and somewhat underappreciated" progress in developing a framework for "the orderly failure of a large, complex, systemically important financial institution". In remarks to the FDIC Banking Research Conference, Chair Gruenberg argued that the Orderly Liquidation Authority framework for "living wills" "avoid[s] the taxpayer bailouts and the market breakdowns that took place during the recent financial crisis."
Chair Gruenberg called the Orderly Liquidation Authority a "backstop" that "effectively [provides] a public-sector bankruptcy process for institutions whose resolution under the U.S. Bankruptcy Code would pose systemic concerns." He asserted that the advantages of the Orderly Liquidation Authority include providing the FDIC the authority to:
- establish a bridge financial company;
- stay the termination of certain financial contracts;
- provide temporary liquidity that may not otherwise be available;
- convert debt to equity;
- coordinate with domestic and foreign authorities in advance of a resolution to better address any cross-border impediments; and
- utilize a large team of professionals in financial institution resolution.
Chair Gruenberg recommended that firms reduce internal interconnectedness between legal entities when under a living will liquidation. Such a move would improve their resolvability in bankruptcy, he noted. He recommended: (i) mapping material legal entities to business lines; (ii) addressing cross-guarantees and potential cross-defaults that spread risk and tie disparate legal entities and operations together; and (iii) ensuring that information technology and other services essential to the functioning of their material legal entities would continue under their resolution strategies.
Chair Gruenberg stated that "there has been no greater or more important regulatory challenge in the aftermath of the financial crisis than developing the capability for the orderly failure of a systemically important financial institution." Under a liquidation pursuant to FDIC authority, "shareholders would lose their investments, unsecured creditors would suffer losses in accordance with the losses of the firm, culpable management would be replaced, and the firm would be wound down and liquidated in an orderly manner at no cost to taxpayers" Chair Gruenberg concluded.
Commentary
Chair Gruenberg's confident assessments add up to an extraordinary assertion of certainty as to the outcome of a crisis, which is inherently a situation whose defining characteristics are panic and uncertainty. Previous bank regulators were equally convinced that the world was under good control, before it turned out to be not so much. Perhaps some degree of greater modesty is now in order.
In the event of a crisis, it will not be obvious that the leaders of a failed bank or institution are "culpable," if that implies moral or criminal guilt. In a market, businesses fail, including banks. Had the federal government not provided liquidity during the last financial crisis, many more financial institutions in the United States might have failed, but that does not mean that every leader of a financial institution is culpable.
Further, the notion that there is some way a precise determination can be made whereby losses to unsecured creditors would be allocated "in accordance with the losses of the firm" presumes an objective calculation of these losses is possible; how can one possibly know what the bank would have been worth had the government not stepped in? Ultimately, it is more likely that the FDIC would announce what the unsecured creditors are paid, and deem this to be fair.
The larger issue is whether Chair Gruenberg's confidence is based on an approach informed by an aversion to risk that will make it impossible for the economy to grow and that will push banks to failure. In a no growth, high compliance cost system, it is inevitable that there will be bank failures. See, e.g., European Supervisors Tell Banks to Be More Efficient (with Lofchie Comment) (September 14, 2015).